Household saving is defined as the difference between a household’s disposable income (wages, income of the self-employed and net property income) and its consumption (expenditures on goods and services.)

Bond Market Is Turning Against Chinese Developers at the Worst Time

Advertisement

A batch of poorly performing dollar bonds from Chinese developers shows investors pushing back on the assets.

The market is going through a repricing as regulators crack down on overheated home prices, issuer fundamentals deteriorate and as the U.S. Federal Reserve likely nears an interest-rate increase.

Meanwhile Chinese developers will have about US$15 billion of offshore bonds maturing or callable in 2017, according to Value Partners, a fund manager. At stake is the health of the Chinese property bond market, which makes up about half of Asian high-yield issuance.

"Bankers have promised companies aggressive [pricing] levels and are facing a changing market, so they have to bridge the gap between the two ... and are more easily pushed back by investors," said Elaine Hu, a fund manager of Value Partners.

The reality of the new pricing environment was most starkly seen for a five-year bond issued by Central China Real Estate Limited, on Nov. 1. The banks behind the five-year deal -- Credit Suisse, DBS Bank, Deutsche Bank, Morgan Stanley and Nomura -- indicated a coupon in the "6% area" at launch. Then, finding there wasn't much interest in the offer, had to push that up to 6.75%.

In today's volatile markets climate, a 0.75 percentage point yield increase might seem minor, but in the bond world it is significant. It added US$7.5 million to the issuer's interest costs -- which is a lot compared with the deal size of US$200 million.

Indeed, most recent high-yield deals from Chinese developers are trading at a loss.

Modern Land (China) Co., Limited's US$350 million three-year dollar bonds priced in mid October were trading with a yield of around 7.55%, a hefty widening on the 7.00% yield at which it was issued. New dollar bonds from Powerlong Real Estate Holdings Ltd. Country Garden Holdings Co. Ltd. and Yuzhou Properties Company Limited issued in September and October are similarly trading under water.

"In general, most recent property bond deals were priced too tight and some were even mispriced. I think syndicate [bankers] may have given too optimistic guidance to developers," said Ben Yuen, head of fixed-income at BOCHK Asset Management.

Chinese developers' high-yield bonds were some of the best performing assets of 2016. But the Chinese government's recent property-tightening measures have hit the securities.

Since late September, at least 21 Chinese cities announced stricter property-buying controls in China to prick an asset bubble in the making, including tighter down-payment rules.

In Shenzhen, where home prices rose 34.5% in the 12 months to September 2016, home prices subsequently started dropping. The National Bureau of Statistics, in an unusual addendum to its monthly data release, said that Shenzhen home prices fell by 0.3% in the first half of October, compared with a 1.9% gain in September from the month before.

Chinese developers are also finding themselves locked out of the highly liquid local debt market, which has been supportive of their issuance over the past two years.

China's stock-exchange operators -- the Shanghai Stock Exchange and Shenzhen Stock Exchange -- recently raised the barriers for developers to tap the onshore bond market, according to local media. New rules circulated by local media in recent days suggest that regulators will prohibit property companies from using proceeds from domestic bond issuance for land purchases.

Property firms also have to be state-owned or ranked in the top 100 developers by the China Real Estate Association, an arm of the country's construction ministry, and need to be rated at least double A by domestic rating firms, to get approval to issue domestic bonds.

The upshot is that developers suddenly need the offshore market. After a long dry spell of being largely deprived of China property bonds, international investors are seeing pricing power come back to them. They are also concerned the domestic market might not be available to backstop the developers should they see cash shortages -- as was the case in the past two years.

The U.S. Federal Reserve is also expected to raise interest rates in December -- Fed Fund futures traded on the Chicago Mercantile Exchange indicate a 71.5% probability rates will rise in the month. China developers will have to raise rates on their offshore deals to account for this increase and others that may come in the months ahead.

Certainly, yields on China property bonds are still tight compared with historical levels or even to where they were at the start of 2016. But the offshore market is turning against the developers just as they need to ramp up issuance to the market.

"Developers could face a double whammy of slowing sales and reduced access to funding, leading to deteriorated liquidity positions. With property prices likely to remain stable or even possibly retract in certain cities, the margins of developers that have acquired land at high cost in the past 12 months will be hurt the most," said S&P Global Ratings credit analyst Cindy Huang.